Exco Resources, a Dallas, Texas-based oil and natural gas producer, has been inching towards bankruptcy for the better part of 2017. Absent a waiver or other forbearance from certain of its lenders, the company, which at one time counted U.S. Commerce Secretary Wilbur Ross as a board member and substantial equity holder, may find itself in Chapter 11 before the end of the year. In this report, the Debtwire legal analyst team reviews Exco’s path to Chapter 11 and previews the potential recovery scenarios for creditors in an Exco bankruptcy.
Exco’s closely-held capital structure
Exco is an independent oil and natural gas company engaged in the exploration, exploitation, acquisition, development and production of onshore U.S. oil and natural gas properties. The company is focused on shale resource plays and operates principally in Texas, Louisiana and the Appalachia region. Exco formally entered the restructuring universe several months ago when CEO Hal Hickey announced in a 9 August 2017 call with investors, which was later reported in the company’s latest 10-Q (30 September 2017), that the company was exploring “strategic alternatives,” including a comprehensive out-of-court or in-court restructuring to address its near-term liquidity needs.
This restructuring involves familiar faces in the distressed debt universe including Oaktree Capital, Bluescape Resources and Fairfax Financial Holdings which together have a controlling position in Exco’s secured debt, which consists of USD 300m 1.5 lien PIK toggle notes and USD 683m 1.75 lien PIK term loans. The company’s full capital structure is below. According to SEC filings, the three funds own 87% or USD 275.2m of the 1.5 lien PIK toggle notes, with Oaktree owning USD 41.7m, Bluescape owning a USD 74m tranche and Fairfax holding the biggest piece with USD 159.5m. Bluescape and Fairfax also control 67% or USD 478m of the 1.75 lien term loan, with the former owning a USD 49.7m piece of the loan and Fairfax holding USD 427.9m.
The PIK toggle notes and term loans were issued in March 2017 in an effort to increase the company’s liquidity by raising capital that would not require cash interest payments. Indeed, the USD 683m 1.75 lien term loans were issued in exchange for an equal amount of USD 683m second lien term loans which carried significant cash interest. The company is able to pay interest on the PIK instruments in common stock or additional debt. Accordingly, the 20 June interest payment on the 1.75 lien term loans was made in common shares and the 20 September interest payment on both the 1.75 lien term loans and the 1.5 lien notes was made through the issuance of additional term loans and notes.
In addition to the PIK notes and term loans, the company has a USD 150m revolving credit agreement led by JP Morgan Chase as administrative agent. Lenders include Bank of America, Wells Fargo, BMO Harris Bank, UBS AG, NATIXIS, Deutsche Bank, Goldman Sachs, Capital One and ING Capital.
The remainder of the company’s capital structure is comprised of USD 131.5m 7.5% senior unsecured notes due September 2018 and USD 70m 8.5% senior unsecured notes due April 2022. Certain of these unsecured noteholders have formed an ad hoc committee to handle debt restructuring negotiations and engaged Brown Rudnick as legal counsel and Miller Buckfire as financial advisor.
The company is represented in its restructuring efforts by Kirkland & Ellis, PJT Partners and Alvarez & Marsal.
Out of cash and out of time
Exco appears to have hit the end of its liquidity runway which the company describes as “constrained” and insufficient to fund business operations and pay indebtedness coming due in the next year. During the third quarter of 2017, Exco exhausted the availability under its revolving credit facility and as of 30 September 2017, had USD 126.4m in outstanding indebtedness and USD 23.6m in outstanding letters of credit under its credit agreement. Cash interest payments totaling USD 8m on the company’s unsecured notes in September and October further drained Exco’s liquidity, which comprised USD 105.8m of cash as of 30 September.
Exco also expects to have a shortfall under a minimum volume commitment for gathering services in the East Texas and North Louisiana regions for the twelve-month period ending 30 November 2017 to the tune of USD 19.5m which is due within 90 days of the end of this period, further constraining the company’s liquidity.
However, what may ultimately push Exco into bankruptcy is a USD 26.9m PIK interest payment due on the 1.75 lien term loans on the 20 December. Exco initially anticipated making this and other PIK payments over the next year with common shares but has been limited in its ability to do so for two reasons. First, the company’s ability to make PIK payments in common shares is subject to a resale registration statement being declared effective by the SEC. That declaration has not yet occurred and it is unclear if the SEC will ever make the statement effective. Second, even if the resale registration statement is declared effective, the collapse in oil prices has pressured Exco’s stock such that the issuance of additional shares of common stock may trigger a change of control under the indenture governing the 1.5 lien notes and the credit agreement governing the 1.75 lien term loans as well as affecting the company’s ability to use NOLs for the coming year. Thus, payment of the PIK interest due on 20 December in common shares does not appear to be a possibility.
Payment of such interest with additional debt also appears to be out of the question. The amount of PIK payments made in additional 1.5 lien notes or 1.75 lien term loans is subject to incurrence covenants within the company’s debt documents that limit the company’s aggregate secured indebtedness to USD 1.2bn. The amount of permitted additional indebtedness currently available under these covenants is only USD 6.9m, whereas the next interest payment due on the 1.75 lien term loans is USD 26.9m, leaving payment in additional debt unavailable as well.
The third and final possibility for payment of the 20 December interest payment on the 1.75 lien term loans is cash. However, this too is currently not permitted under the company’s debt documents. The credit agreement governing the 1.75 lien term loans restricts the company’s ability to pay interest in cash unless Exco has liquidity, on a pro forma basis, of at least USD 175m, which it currently does not have. Accordingly, the company notes in its latest 10-Q that unless it obtains a waiver or other forbearance from certain lenders that it will not be able to make this interest payment.
If the company is not able to make the 20 December interest payment and other scheduled payments on its debt, then the bankruptcy dominoes will start to fall as an event of default under the 1.75 lien credit agreement would cause a cross-default and acceleration of the company’s other notes and loans.
In other words – Houston, or Dallas as is more appropriate here, we have a problem.
Short runway with bank waiver
Exco may attempt a Hail Mary and seek a waiver or other forbearance from its lenders so that it can make the 20 December interest payment, likely to be with additional debt rather than with common shares or cash. However, this would provide Exco with little runway as it is currently in violation of one of its financial covenants and warns that additional violations will soon follow.
In September, Exco’s JP Morgan-led bank group agreed to a one-time waiver of an event of default resulting from Exco’s failure to comply with a leverage covenant that tests its aggregate revolver exposure to consolidated EBITDAX. The company notes in its latest 10-Q that it will likely not be able to comply with this covenant as of 31 December 2017 either and that a breach of any covenant under this credit agreement could also cause an event of default under the indenture governing the 1.5 lien notes, the credit agreement governing the 1.75 lien term loans and the indentures governing the senior unsecured notes.
Exco also revealed in its 10-Q that it will likely not be able to meet the minimum liquidity test under its first lien credit agreement which requires the company to have cash of at least USD 50m at the end of every month and USD 70m at the end of every quarter. The company warns that a violation of this covenant could come as early as the end of the fourth quarter of 2017. Further adding to the violations, Exco notes that its ability to meet a covenant that tests its consolidated interest expense expenses to consolidated EBITDAX is also in jeopardy.
But the problems do not stop there. If the company delivers an audit report to its lenders with respect to the financial statements for the fiscal year ended 31 December 2017 expressing uncertainty as to its ability to continue as a going concern, which it now has, this will cause an event of default under the first lien credit agreement, the 1.5 lien notes indenture and 1.75 lien term loan agreement and, as with other covenant and payment defaults, result in a default under the indenture governing the senior unsecured notes. If this occurs and Exco’s indebtedness is accelerated and becomes immediately due and payable, the company’s liquidity would not be sufficient to pay such indebtedness.
Chapter 11 on the horizon
It thus seems clear that Exco is heading for Chapter 11 and soon if it is not able to secure a forbearance or waivers to enable it to make the 20 December 1.75 lien term loan interest payment or waivers with respect to any covenant violations that are expected to come by the end of the year. What might an Exco Chapter 11 look like? Given that the company has an unusually large amount of secured debt as compared to its modest amount of unsecured notes, the company’s secured creditors, and the trio of Oaktree, Bluescape and Fairfax in particular, are likely to be leading the way in the restructuring.
Indeed, the company may already have a deal in place with its secured lenders in which case it may enter bankruptcy with a restructuring support agreement in the hopes of a swift trip through Chapter 11. We do know that Exco is looking towards a Chapter 11 filing as Debtwire reported on the 7 December that PJT Partners was arranging meetings on behalf of the company to explore DIP financing options. In today’s depressed oil and natural gas price environment it can be difficult to obtain financing from a third party so we may see the company’s first lien lenders provide the DIP facility, but on the condition that the prepetition credit agreement is rolled up into the post-petition DIP loan facility.
In terms of a plan, a likely and familiar scenario would be to hand over the equity in reorganized Exco to Oaktree, Bluescape and Fairfax and other holders of the 1.5 lien notes and 1.75 term loan. Debtwire reported back in August that these holders were expected to drive negotiations for a plan of reorganization that would give them the bulk of the reorganized equity. In this scenario, Fairfax, which holds more than half of both of these tranches, could be in control of over 50% of the reorganized company.
Much further down the line in terms of recovery are the unsecured noteholders which comprise a mere USD 200m of the company’s USD 1.4bn in debt. The extent of crossover ownership with the company’s secured debt is not known, but may be a factor that influences their recovery, especially if it means getting the unsecureds signed on to a restructuring support agreement or plan, and thereby avoiding a valuation fight or other costly litigation. In this scenario, unsecured noteholders may receive a small amount of cash, the ability to participate in a rights offering backstopped by Oaktree, Bluescape and Fairfax or a small piece of new secured debt. Either way, the unsecured noteholders are unlikely to hold much leverage and may be forced to accept a plan with a nominal recovery or risk getting wiped out entirely.
A near term Chapter 11 for Exco appears to be inevitable. Whether the company enters bankruptcy with a comprehensive deal in place or not, the leverage is with the company’s secured creditors and, more specifically, Oaktree, Bluescape and Fairfax. Like the company, unsecured noteholders may find themselves out of time and out of cash.
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by Sarah Foss
Sarah Foss is a former practicing restructuring attorney. Prior to joining Debtwire as a Legal Analyst, Sarah practiced in the New York and Houston offices of Winston & Strawn LLP and Dewey & LeBoeuf LLP in the area of business reorganizations, including complex Chapter 11 cases and out-of-court restructurings. She has represented large corporate debtors, creditors’ committees, secured lenders, distressed asset acquirers and investment banks across a broad range of industries.
Any opinion, analysis or information provided in this article is not intended, nor should be construed, as legal advice, including, but not limited to, investment advice as defined by the Investment Company Act of 1940. Debtwire does not provide any legal advice and subscribers should consult with their own legal counsel for matters requiring legal advice.
 The 1.5 lien notes and 1.75 lien term loans are secured by second priority liens and third priority liens, respectively, on substantially all of EXCO’s assets and the assets of its guarantors.
 After the debt exchange, the company was left with approximately USD 17.2m of the second lien term loans outstanding.
 During 2015 and 2016, Exco completed exchanges and a series of open market repurchases of its senior unsecured notes which significantly reduced the aggregate principal amounts outstanding.